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Assessment of Industry¶s readiness ± Survey by KPMG

Opportunities, Concerns and Challenges

What needs to be done to ensure effective implementation and


within the RBI time frame ± Action Points for effective
Implementation
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Coverage of the Survey

Total 32 banks Total Banking Assets:


 9 public sector banks 61%
 6 new private sector banks Total Profit (after tax):
 12 old private sector banks 68%
 5 foreign banks

Key Aspects in the questionnaire

The Drivers Techonological readiness


The Project plan esource Planning
Perceivedbenefits andchallenges
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Other Findings:
16% of the banks surveyed have commenced the process of
planning for the more advanced approaches of Basel II,
including collection of loss data, risk mitigation techniques and
capital modelling.
Compliance with regulation is driving the Basel II
implementation programme in 46% of the banks surveyed.
New private sector banks ranked enterprise risk management
over compliance as their key driver.
89% of the banks surveyed indicated that they have a
µdedicated team¶ responsible for Basel II implementation.
However, very few banks have established the position of Chief
Risk Officer with a reporting line to the CEO/Board and whose
role has been defined with sufficient clarity.
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Credit Risk Preparedness
71% of the banks responded that they had made reasonable
progress with the initial stages (in the form of establishing the
team, conducting gap analysis, pro ect planning and assessing
detailed requirements) of implementing a credit risk
programme.

The more advanced stages of credit risk preparedness have


shown minimal progress as well as varied understanding of the
implementation approach.
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Operational Risk Preparedness
Most banks have started work on the Basic Indicator Approach
(BIA) for operational risk management. However banks appear
to be unclear on their time frames for adopting more advanced
approaches. Appropriate guidance from the regulator could be
one of the reasons.
Technological adaptability could be one of the drivers that
would enable banks to implement the Standardised and
Advanced Measurement Approach for operational risk
management.
A large number of banks seem to have not yet fully understood
the complexities for Basel II compliance in respect of
operational risk.
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Technological Preparedness
There appears to be less clarity with regard to use of
technology in operational risk.

On a scale of 5, Credit risk technological preparedness range


between 3.0 to 3.5, Market risk technological preparedness
range between 3.2 to 3.5 and Operational risk technological
preparedness range between 2.0 to 2.5 among various public
and private sector banks.
90% of the banks intended to use a combination of in-house
development as well as external consultants to build
appropriate IT solutions.
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Measuring,Managing and Monitoring Risk in a scientific


manner

Align risk appetite and business strategy

Risk Based Pricing

Effective Portfolio Management

Optimum utilization of Capital

Enhance shareholders¶ value by generating risk ad usted


return on capital
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Guidance and support from senior management is essential to
help ensure success of Basel II pro ect. Without their support
and motivation, implementation can become difficult and time
consuming.

Good risk management involves a high degree of cultural


changes. Embedding good risk management practices into the
day to day business processes will be a daunting task.

Sophisticated risk management techniques, particularly under


the advanced approaches, require human resources with
appropriate skill sets and proper training. With average age of
45 and above of Public Sector Bank officers, the task becomes
much more challenging.
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Capital requirement under Basel II will increase due to
additional capital charge for operational risk and increased
capital requirement for market risk (already implemented wef
31.03.2006). The scarcity of resources (of raising capital) will
add to the existing competition of business growth. Highly
rated corporates (needing lower amount of capital) may exert
pressure on already declining interest spread.
The models under advanced approaches require lot of
historical data. However, with no data warehouses in the banks
(especially Public Sector Banks), collection of data is a
formidable task.
Methodologies that work in a bank may not work in another
bank. Banks have to customize and tailor make the risk
products to suit their processes.
Challenges for Banks ± Legal and Regulatory Infrastructure

Steps are required for adoption of internationally accepted


accounting standards, consistent, realistic and prudent rules
for asset valuation and loan loss provisions reflecting realistic
repayment expectations.
Legal systems will require changes for speedier and effective
liquidation of collaterals

The laws governing supervisory confidentiality and bank


secrecy would require modifications to permit disclosure
envisaged under pillar III.
In view of predominant Government control over public sector
banks, preconditions such as operational autonomy, corporate
governance etc need to be addressed.
Challenges for Banks ± External Credit Rating Agencies

Limited number of rating agencies and insignificant level of


penetration of ratings.

The rating agencies in India have a good background in rating


³issues´ such as corporate bonds, commercial papers and other
marketable instruments, but not in rating issuers/bank
borrowers.

At present default rates are disclosed by CRISIL only and


other rating agencies are yet to declare the default rates,which
may create difficulties in mapping process and compliance with
disclosure criterion. Other rating agencies will have to disclose
the default rates if they want to be accredited by RBI.
Challenges for Banks ± External Credit Rating Agencies

In India banks/ FI¶s are having stake in rating agencies that


may impact the independence of rating agencies.
Banks are also awaiting detailed guidelines from the regulator
on matter involving regulatory discretion under Internal rating
based approach. Such guidelines are required to enable the
banks to start collecting the data properly and to design IRB
compliant risk management systems.

The capital requirements of banks under Standardised


approach will be less sensitive to credit risk compared to banks
on advanced approaches, may result in higher risk loans going
to banks on standardised approach. This may lead to
concentration of high risk assets with banks adopting
standardised approach and low risk assets with banks adopting
IRB approach.
Challenges for Banks ± evelopment of market for Credit
derivatives and other credit mitigation products

Credit derivative products yet to be introduced in India.


Evolution of developed market for credit derivative is required to
mange credit risk effectively and to get full benefit of risk
mitigation.

Rigorous legal and regulatory framework and less developed


secondary market for bonds/ loans etc is a ma or impediment in
development of credit derivative markets.
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Presently, no single IT supplier can provide all-round risk
management solutions. However, 100% internal development
may be too costly because risk management methodologies tend
to involve complex computation. Integrating various external
systems into one platform is the ma or challenge. Flexible
customization of external systems is important .

System integration, dedicated software for risk assessment and


management and setting up of enterprise wide integrated data
warehouse shall pose a formidable challenge for Indian banks.

Ensuring correct feeding of data from various sources and the


validation of information stored is a ma or challenge to be
overcome before the banks start making use of the information
in the data warehouse.
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Lack of data driven culture
Historical issues in getting reliable data.
Only data that was necessary to ease operational processes
was captured.
Structured, data-backed decision-making has not been very
prevalent.
Most of banks are having various banking solutions across
branches. Co-ordinating with multiple vendors each handling
different parts of the overall solution in the present system is a
daunting task.

Inadequacy of relevant and reliable data to estimate risk inputs


for advanced techniques ± shall make the implementation
difficult in Indian conditions.
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Short data history, and lesser number of data points in LG ,


EA and high impact low frequency events in operational risk
may give distorted results. Effort for creation of pooled data are
required to be made requiring collaborative efforts between
banks and supervisor.

Risk methodologies and business processes are evolving. The


technologies adopted must be flexible for future changes.
 
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Grooming and Retaining Talent
Percolating risk culture across the organisation through frequent
communications, organizing seminars and training.

Setting up of ata Warehouse to provide risk management


solutions.

Integrating risk management with operational decision making


process by conducting periodic use tests.

Periodic backtesting and stress testing of the existing models to


test their robustness in the changing environment and make
suitable amendments, if required.
 
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Putting in place a comprehensive plan of action to capture risks
not captured under Pillar I, through ICAAP framework.

Handling interrelationship between businesses. Linkage needs to


be established between Funds Transfer Pricing, Asset and
Liability Management, Credit risk, Market risk and Operational
risk so that cost allocation can be done in a scientific manner.

For Pillar III requirements, banks should disclose information,


that are easily understood by the market players and gradually
move to disclosure of informations requiring advanced concepts
and complex analysis.
Adopting RAROC framework and moving from regulatory
capital to economic capital.

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